· Web viewAnother contributor is the steady increase in agriculture emissions, which is not covered by carbon pricing. Growth in domestic emissions is projected to average 0.4 per

Chapter 3: Australian projectionsThis chapter presents projections for Australian emissions and the structure of the Australian economy for a range of alternative carbon policy scenarios.1 The emissions projections are developed and presented at a sectoral level, encompassing domestic emissions from stationary energy (including electricity generation and direct combustion), transport, fugitive emissions from fuel production, industrial processes, agriculture, waste and deforestation and reforestation. Australia’s domestic emissions are defined as all emissions from within Australia, less all removals within Australia, measured and defined in accordance with the Kyoto Protocol. The choice of scenarios is designed to present a central projection and illustrate a range of alternative projections around it.

The projections present point estimates of emissions and economic outcomes under each scenario. They rely upon judgments about growth in the global and domestic economy, the implementation of policy actions, technological innovation and behavioural responses. The future course of the Australian economy in aggregate and at a sectoral level is subject to uncertainty and will be influenced by events that cannot be anticipated. These uncertainties increase over time so that emissions projections for 2030 have greater potential variation than those for 2020.

5.1 Description of scenariosProjections are presented for three scenarios with carbon pricing in Australia, including the Carbon Farming Initiative (CFI). The policy scenarios have been developed on the basis of policies at the time of writing including: the Clean Energy Future plan announced in 2011; linking arrangements with the European Union emissions trading scheme and sub-limits on the use of Certified Emissions Reductions (CERs); and the 16 July 2013 announcement to bring forward the timing of the move to a flexible price scheme. Each policy scenario commences with a fixed nominal carbon price of $23 in 2012-13, rising to $24.15 in 2013-14 before transitioning to a flexible price cap-and-trade scheme from 1 July 2014. A summary of the scenario design is presented in Table 3.1.

The three policy scenarios are:

• Central policy scenario — Assumes a world with medium global action as described in chapter 2 and an Australian emissions target

1 All years referred to in this chapter are financial years ending in that year (that is 2011-12 is 2012) and values are in 2011-12 Australian dollars unless otherwise stated. Comparisons to current values relate to 2012 levels.

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Climate Change Mitigation Scenarios

of a 5 per cent reduction on 2000 levels by 2020 and an 80 per cent reduction by 2050. After the fixed price period, the price of Australian carbon units is assumed to follow a linear transition from December 2014 EUA futures market prices through to a price of A$36/t CO2-e in 2020 (equivalent to 2012 A$30) which is consistent with a transition to the modelled international price from 2021.

• Low price scenario — Assumes a world with medium global action and an Australian emissions target of a 5 per cent reduction on 2000 levels by 2020 and an 80 per cent reduction by 2050. After the fixed price period, the price of Australian carbon units is assumed to grow from December 2014 EUA futures market prices at a rate of 4 per cent per year plus inflation to reach A$8/t CO2-e in 2020 (2012 A$6), before following a linear transition to the modelled international price in 2030.

• High price scenario — Assumes a world with more ambitious global action as described in chapter 2 and an Australian emissions target of a 25 per cent reduction on 2000 levels by 2020 and an 80 per cent reduction by 2050. After the fixed price period, the price of Australian carbon units is assumed to follow a linear transition from December 2014 EUA futures market prices through to a price of A$89/t CO2-e in 2020 (2012 A$73) which is consistent with a transition to the modelled international price (described in chapter 2) from 2021.

Chart 3.1: Projected Australian carbon unit prices

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From 1 July 2014, when the carbon price mechanism transitions to the flexible price period, the cap on carbon pollution in sectors covered by the carbon price (the ‘scheme cap’) will reduce Australia’s net emissions. In the sectors covered by the carbon price, if domestic abatement falls short of the level required to meet the scheme cap, it is projected that

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Chapter 3: Australian projections

liable entities would purchase eligible international abatement permits. This may include a combination of European Union Allowances (EUAs) and CERs validated by the United Nations Framework Convention on Climate Change (UNFCCC). While the scheme cap is yet to be determined for that period, the total number of international permits purchased by Australian entities is assumed to make up any difference between the level of domestic emissions and Australia’s net emissions trajectory.

The central policy scenario assumes a national trajectory to 2020 consistent with Australia’s provisional quantified emissions limitation or reduction objective (QELRO) and unconditional -5 per cent 2020 target. Australia has nominated a provisional QELRO of 99.5 per cent of 1990 levels over the eight years to 2020, equivalent to an average of 578 Mt CO2-e per year. The trajectory is determined as a straight line from Australia’s first Kyoto commitment period assigned amount of 616 Mt CO2-e in 2010 (expressed using Fourth Assessment Report global warming potentials) to achieve the unconditional commitment of a reduction in emissions of 5 per cent below 2000 levels in 2020. The Government has committed that abatement through voluntary GreenPower purchases will be in addition to these reductions, as discussed in Appendix B. Beyond 2020, it assumes a straight-line transition to a reduction in emissions of 80 per cent on 2000 levels by 2050. The low price scenario assumes the same national trajectory as the central policy scenario.

In the high price scenario, the national trajectory assumes a straight-line pathway from Australia’s first commitment period assigned amount in 2010 to a reduction in emissions of 25 per cent below 2000 levels in 2020. Beyond 2020, it assumes a straight-line transition to a reduction in emissions of 80 per cent on 2000 levels by 2050.

Chart 3.2: National emissions trajectory

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Note: GreenPower abatement is not included in these trajectories.Source: National Greenhouse Gas Inventory; UNFCCC (2009).

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During the flexible price period, it is assumed that the Australian carbon unit price moves with the EUA price until 2020. Limits apply to the use of international permits within the Australian carbon pricing mechanism during this period. Liable entities may use international units to meet up to 50 per cent of carbon pricing mechanism liabilities, although the emissions profiles presented in these projections would not see this overall limit bind. Within the overall limit, usage of CER units is restricted to 6.25 per cent of liabilities in 2014-15 and 12.5 per cent of liabilities thereafter. CER units are assumed to trade at a lower price than EUAs throughout the period to 2020, based on the relative market prices in recent months. As these limits scale with liable entities’ emissions, the effective marginal carbon price faced by domestic firms is taken to be a weighted average of the Australian carbon unit price and the CER unit price over the period to 2020, with weights reflecting the CER sub-limit.

The scenario design ignores the potential to carry over a bank of units across years. The modelling does not assume that Australia’s surplus from the first commitment period of the Kyoto protocol is available for use during the flexible price period. Internationally-sourced abatement is assumed to be used only to the extent needed to meet Australia’s emissions trajectory year by year.

A ‘no carbon price’ scenario, in which there is neither carbon pricing nor the CFI, is also presented. This scenario includes abatement from pre-existing measures such as energy efficiency measures and the Renewable Energy Target (RET).

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Table 3.2: Domestic policy scenario assumptionsCentral and low price scenarios High price scenario

Global action Medium global action consistent with long-term stabilisation of atmospheric concentrations of greenhouse gases at 550 ppm CO2-e.

Ambitious global action consistent with a 50 per cent chance of limiting temperature increase to 2 degrees Celsius above pre-industrial levels and long-term stabilisation of atmospheric concentrations of greenhouse gases at 450 ppm CO2-e .

Australian emissions reduction target

5 per cent below 2000 levels by 2020; 80 per cent below 2000 levels by 2050.

25 per cent below 2000 levels by 2020; 80 per cent below 2000 levels by 2050.

Trajectory Set as a straight line from the mid-point of Australia’s first commitment period QELRO to a target of 5 per cent below 2000 levels in 2020, consistent with Australia’s second commitment period QELRO; and from 2020 as a straight line to a 2050 target of 80 per cent below 2000 levels.

Set as a straight line from the mid-point of Australia’s first commitment period QELRO to a target of 25 per cent below 2000 levels in 2020; and from 2020 as a straight line to a 2050 target of 80 per cent below 2000 levels.

International linking

No international linking during the fixed price period. Linkage to the EU ETS (initially as a one-way link) from 2015 to 2020 with quantitative restrictions to ensure liable parties meet at least 50 per cent of their annual liability from domestic permits and credits until 2020, and no more than 6.25 per cent through CERs in 2015 and 12.5 per cent in other years. Transition to a common international price from 2021.

Coverage

All emissions sources are covered directly by the carbon price or indirectly through an equivalent price, except:

* activity emissions from agriculture;

* combustion emissions from agriculture, forestry and fishing;

* on-road combustion of liquid fuels by light vehicles and gaseous fuels;

* on-road combustion of liquid fuels by heavy vehicles in 2012-13 and 2013-14;

* decommissioned mines;

* land use, land-use change and forestry;

* legacy waste;

* synthetic gases imported prior to the introduction of carbon pricing; and

* emissions from facilities below the coverage threshold (generally 25 kt CO2-e).

Emissions reductions in land use, land-use change and forestry, legacy waste and agriculture are eligible for CFI credits.

Emissions-intensive trade-exposed activities

Assistance to activities starts at 94.5 per cent or 66 per cent of historical emissions intensity baselines, declining at an annual rate of 1.3 per cent per year before being assumed to phase out in five steps beginning in 2022. LNG facilities receive assistance of a minimum 50 per cent of emissions. The steel industry receives a 10 per cent increase in permit allocations from 2016-17.

Fuel An equivalent carbon price is applied to: businesses’ combustion of liquid fuels from 2012-13 (except light vehicles, agriculture, forestry and fishing) and heavy on-road vehicles from 2014-15, through the fuel tax credit system; and aviation fuel from 2012-13 through the domestic aviation excise system. Private passenger cars are excluded.

Use of permit revenue

Net scheme revenue is allocated to households as lump sum payments.

3.1 Economic growth in the central policy scenarioA detailed outlook for the composition and volume of production in the Australian economy was modelled as a backdrop to the emissions projections. The economic projections are designed to allow construction of emissions series and the focus of the analysis is on detailed projections by third parties for the emissions-intensive industries within the agriculture, mining, manufacturing, transport and electricity sectors. A

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snapshot is presented based on the data available while it was being prepared (Box 3.1 discusses recent changes to economic parameters).

Box 3.1: Recent changes in the economic outlookThe projections provide a snapshot consistent with the macroeconomic parameters in the 2013-14 Budget. A number of projection parameters changed between the Budget published in May 2013 and the Pre-Election Economic and Fiscal Outlook published in August 2013. These include a downward revision of real GDP growth forecasts by ¼ percentage point in 2013-14, a downward revision to the terms-of-trade forecasts on the back of weaker Chinese growth to a level around 10 per cent lower in 2014-15 than previously forecast, and an exchange rate assumption of 91 US cents down from 103 US cents at the time of the Budget.

Given the long lead times in commissioning detailed modelling of the electricity generation, transport, agriculture and other sectors, it was necessary to settle on the broad macroeconomic parameters early in the process. Sensitivity analysis suggests that a reduction in the terms of trade of 10 per cent will tend to add 3 to 5 per cent to employment, investment and output levels (relative to baseline) in manufacturing and agriculture sectors as a whole, consistent with previously published analysis (McKissack et al 2008; Swift 2006), and will tend to increase the overall level of emissions in the economy. Output projections for the emissions-intensive manufacturing and agriculture sectors included in this report have been adjusted to accommodate the changed forecasts for the terms of trade.

The central policy scenario shows continued economic growth, with real GDP projected to grow by around one-third over the decade to 2020 and a further one-third over the decade to 2030. As the population grows and the economy expands, employment increases, by around 1.5 million people over the period to 2020 and a further 1.7 million over the decade to 2030.

The central policy scenario is also a story of ongoing structural transformation driven by demographic change, movements in the terms of trade, competition from producers in other countries and uneven productivity growth across industries. Near-term rates of productivity growth are based on historical patterns for each industry. Consumer preferences are projected to continue their historical trend changes. As discussed in section 3.6, carbon pricing has little effect on this process of structural transformation at the level of broad industry sectors.

Growth across sectors varies; the strongest percentage growth is in mining and related industries over the coming decade, due to the high level of investment in recent years and committed investment in coming years. Of particular note is the rapid expansion of the volume of gas production, particularly for liquefaction and export. The modelling assumes rising international gas prices and convergence of east coast

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domestic prices towards parity with international prices, net of export costs associated with liquefaction and transport. Production of coal and iron ore also continues to rise, with the strong investment of recent years boosting production and export growth in years to come.

Chart 3.1: Industry shares of employment, 1990 to 2030Central policy scenario

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The ongoing growth in the mining sector maintains pressure on other trade-exposed sectors. The period of very strong commodity prices in recent years contributed to a sustained high exchange rate, reducing the competitiveness of other trade-exposed industries, such as manufacturing. The expansion of investment and production in resource projects has also drawn capital and labour to the mining sector, where the rate of return has been higher. Over time, prices of some resource commodities are projected to decline as more supply comes on line, and the exchange rate falls, assisting those other trade-exposed industries.

The high commodity prices have accelerated the relative decline in the size of the manufacturing sector as a share of the economy in recent years, a process that has been underway since the middle of the twentieth century. Output in the manufacturing sector as a whole is projected to remain fairly flat over the period to 2020, with continued growth in areas like food manufacturing offsetting declines in sectors like aluminium smelting and petroleum refining. Manufacturing output returns to growth in the following decade, albeit at a slower pace than the economy as a whole.

The level of agricultural production and exports has also been affected by the high exchange rate over recent years and the near-term outlook is for moderate growth rates. With the improvement in seasonal conditions since 2010, farmers have rebuilt their flocks and herds to a level projected to stabilise in the short term. After 2020, herd levels are

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projected to continue to increase, as rising international demand and improved competitiveness from a declining real exchange rate expands production across all major agricultural commodities.

Australia’s services sector, which is currently around two-thirds of the economy, expands to meet growing domestic and international demand. The sector, which includes education, tourism, business services, utilities, transport, retail and wholesale trade, continues to grow slightly faster than the economy overall.

Construction output continues to grow, but at a slower rate than in recent years as the peak in mining investment passes. The construction share of the economy declines over time from its recent high level.

Closer engagement and integration with the rapidly growing Asian economies continues to influence the volume and composition of Australian trade. Over the past decade, the most pronounced effect has been through stronger demand for Australia’s mineral and energy resources. With the share of mining in Australia’s exports projected to peak towards the end of the current decade, the burgeoning Asian middle class will generate growing demand for a wide range of Australian products, including higher-value foods, education, professional services and tourism.

Chart 3.2: Export shares by industryCentral policy scenario

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Another key economic trend pertinent to the emissions outlook is the projection for electricity consumption. It is projected to grow throughout the entire projection period. This follows an unusual period of falling electricity consumption in the National Electricity Market (NEM), by 3 per cent over the three years to 2012. The drivers contributing to this historical reduction in energy demand include: electricity network and

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transmission costs feeding through to retail price increases; below-trend GDP growth for most of the period; slower growth in the energy-intensive industrial sectors of the economy; and more rapid installation of small-scale solar photovoltaic systems.

In the projections, expansion of the liquefied natural gas (LNG) industry in Queensland contributes strongly to near-term growth in electricity demand. Longer-term growth in electricity demand is driven by population and economic growth, which in turn drive growth in residential and commercial demand, while demand from heavy manufacturing stabilises.

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Box 3.2: Electricity demand in the NEMThe aggregate electricity demand figures in this chapter incorporate projections for the National Electricity Market (NEM), which represents around 85 per cent of total generation, as well as the South West Interconnected System, North West Interconnected System, Darwin-Katherine Interconnected System, off-grid generation, solar photovoltaic (PV) and small non-scheduled generation.

The Australian Energy Market Operator (AEMO) also publishes annual projections of generation in the NEM, as well as high and low sensitivity analyses, which can be compared with the NEM component of the aggregate electricity demand figures in this chapter.

The central policy scenario projections presented in this chapter are broadly in the middle of the high and low series published by AEMO. Compared to AEMO’s medium projection, the main difference in the period to 2020 is the central policy scenario projections assume somewhat slower growth in industrial demand than AEMO’s, with electricity-intensive industries such as aluminium reducing demand. This compares with relatively flat industrial demand in AEMO’s medium scenario in all states except Queensland, where LNG production adds to demand. In the longer term, the central policy scenario projections converge towards the AEMO medium projection due to more rapid growth in residential and commercial electricity demand, partly reflecting more conservative assumptions in the current report around energy efficiency improvements.

Chart 3.1: NEM electricity generation sent out

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Central policy AEMO - High AEMO - Medium AEMO - LowNote: AEMO series are the sum of native energy (sent out basis), solar PV and small non-scheduled generation. Differences in coverage result in small differences in the starting level.Source: Estimates from MMRF and AEMO (2013).

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3.1 Australia’s abatement task and net emissionsAustralia has committed to unconditionally reducing emissions in 2020 by at least 5 per cent below 2000 levels. To meet the unconditional -5 per cent target, the projected abatement task is a cut of 131 Mt CO2-e in 2020 compared to the no carbon price scenario.

Australia is projected to meet this abatement task through a combination of domestic abatement—including reductions from levels without carbon pricing or the CFI—and abatement sourced overseas through the purchase of international carbon permits. Abatement is more expensive in Australia than in many economies due to relatively cheap access to fossil fuels. The modelling assumes some abatement is sourced overseas so that Australia’s net emissions match the national trajectory.

In the central policy scenario, half of the abatement challenge is met through the reduction in domestic emissions in 2020 and half through abatement sourced overseas. In the low carbon price scenario, a smaller share of the abatement challenge is met through reductions in domestic emissions and a larger share through abatement sourced overseas.

In the high price scenario, domestic abatement is more than twice as large in 2020 and 2030 as in the central policy scenario. However, the abatement task is also larger because the trajectory is assumed to decline faster, and internationally-sourced abatement continues to play a role.

Chart 3.2: Australia’s net emissions and sources of abatement Central policy scenario

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Chart 3.6: Australia’s net emissions and sources of abatement (cont.)Low price scenario

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Source: Estimates from MMRF.

3.2 Domestic emissions projectionsDomestic emissions projections are prepared at a sectoral level, with sectoral definitions consistent with international guidelines adopted by the UNFCCC for accounting under the Kyoto Protocol. The projections are prepared for Kyoto Protocol greenhouse gases and expressed in terms of carbon dioxide equivalent (CO2-e) using the 100-year global warming potentials contained in the Intergovernmental Panel on Climate Change’s Fourth Assessment Report (IPCC 2007a). As greenhouse gases vary in their radiative activity and in their atmospheric residence time,

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converting emissions into CO2-e allows the aggregate effect of emissions of the various gases to be considered.

The policy scenarios incorporate projected effects of carbon pricing and the CFI. Emissions covered by the carbon pricing mechanism include those from stationary energy; industrial processes; fugitive emissions from the production of coal and gas; and emissions from non-legacy waste (that is, waste deposited after the commencement of the carbon pricing mechanism). An equivalent carbon price is also applied to some transport fuels through the fuel tax regime and to importation of synthetic greenhouse gases. Overall, this covers around two-thirds of Australia's emissions directly and through other means. The CFI provides an incentive for emissions reductions in the land use, land-use change and forestry (LULUCF) and agriculture sectors, and the waste sector for legacy waste.

Detailed sectoral modelling has been integrated into the economic projections. This means that differences in carbon price assumptions flow through to differences in emissions levels both through their effects on the level and distribution of production across industries and through the incentive they create to reduce the emissions intensity of production within each industry.

The central policy scenario projects domestic emissions to rise slowly from current levels. Two contributors to this increase are direct combustion and fugitive emissions, both of which reflect the rapid growth projected for gas extraction and liquefaction. Another contributor is the steady increase in agriculture emissions, which is not covered by carbon pricing. Growth in domestic emissions is projected to average 0.4 per cent per year over the period from 2012 to 2030. This is below the rate of growth projected for the economy and population, so that indicators of the emissions intensity per unit of production in the economy or per person fall steadily over the period.

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Chart 3.3: Economy-wide trends in emissions intensityCentral policy scenario

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Carbon prices provide an incentive for firms to reduce the emissions intensity of their production processes and, by changing the relative costs of producing different goods and services, encourage the movement of resources towards lower emissions-intensive industries. Compared with the no carbon price scenario, the combination of carbon pricing and the effects of the CFI lead to 65 Mt CO2-e of domestic abatement in 2020 and 156 Mt CO2-e in 2030. Cumulative domestic abatement of 294 Mt CO2-e is achieved to 2020 and 1444 Mt CO2-e to 2030. Overall, changes in emissions intensities within industries contribute around three-quarters of domestic abatement in 2020 and two-thirds of abatement in 2030, while changes in the structure of the economy deliver the balance.

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Chart 3.4: Emissions by sectorCentral policy scenario

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Chart 3.8: Emissions by sector (cont.)Low price scenario

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One way to compare each sector’s role in meeting Australia’s abatement task is to look at the percentage reduction in emissions within each sector. All economic activities covered by carbon pricing, or for which CFI credits are available, see reductions in emissions over time relative to levels in the no carbon price scenario. In the low price and central policy scenarios, the proportionate reductions are generally smaller in combustion emissions in electricity, transport and stationary energy than activity emissions. In the high price scenario, however, carbon pricing drives larger reductions in emissions from the electricity generation sector.

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Chart 5.1: Emissions reductions by sectorChange from no carbon price scenario, 2020

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Another way to compare each sector’s contribution to meeting Australia’s abatement task is to add up the cumulative emissions reductions in the policy scenario compared to the no carbon price scenario over the period to 2030. Over this period, the electricity generation and fugitives sectors deliver the greatest share of the reduction in domestic emissions in all scenarios.

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Chart 3.5: Share of cumulative emissions reductions by sectorChange from no carbon price scenario, 2013 to 2030

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Detailed reports on the electricity sector prepared by ACIL Allen Consulting, the transport sector prepared by the CSIRO and the agriculture sector prepared by the CIE are available on the Climate Change Authority website.

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Table 3.2: Domestic emissions projections1990 2000 2012

No carbon price Low price

Central policy High price


Central policy High price

Mt CO2-e Mt CO2-e Mt CO2-e Mt CO2-e Mt CO2-e Mt CO2-e Mt CO2-e Mt CO2-e Mt CO2-e Mt CO2-e Mt CO2-eEnergy Emissions 294 367 431 498 477 460 405 584 500 476 319

Abatement -20 -37 -93 -84 -108 -265Stationary Emissions 195 251 292 320 310 301 254 378 333 317 187

Abatement -10 -19 -66 -45 -61 -191Transport Emissions 62 75 91 99 96 94 92 106 99 91 83

Abatement -2 -4 -6 -7 -15 -23Fugitive Emissions 37 41 48 79 71 66 59 100 69 67 50

Abatement -8 -14 -21 -31 -33 -51Industrial processes Emissions 26 26 32 37 32 27 21 45 24 22 11

Abatement -5 -10 -16 -21 -23 -34Agriculture Emissions 99 105 100 106 104 103 102 123 119 119 117

Abatement -1 -3 -3 -4 -5 -6Waste Emissions 21 17 15 15 13 12 11 15 9 8 7

Abatement -2 -3 -4 -6 -6 -8Forestry Emissions 0 -11 -25 -19 -22 -24 -26 -17 -23 -23 -26

Abatement -3 -5 -7 -6 -6 -8Land-use change Emissions 140 82 47 50 47 43 38 51 42 42 37

Abatement -3 -7 -11 -9 -9 -14Total Emissions 580 586 600 685 651 620 551 801 672 644 465

Abatement -35 -65 -134 -129 -156 -335

2020 2030

Source: Historical data from the National Greenhouse Gas Inventory. Land use, land-use change and forestry estimates are from DIICCSRTE. All other estimates are from MMRF.

Page 55 Climate Change Mitigation Scenarios


3.2.1 Electricity sectorEmissions from electricity are associated with fuels combusted to generate electricity, including both on-grid and off-grid generation. Electricity sector emissions accounted for around 198 Mt CO2-e in 2012, or around 33 per cent of Australia’s total domestic emissions.

Chart 3.1: Electricity emissions, 2000 to 2030

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Source: National Greenhouse Gas Inventory; projections from MMRF and ACIL Allen Consulting.

In the central policy scenario, the composition of electricity generation in Australia changes markedly over time. The carbon price drives changes in the mix of technologies and fuels used in the electricity sector in all policy scenarios in the period to 2020 and, particularly, over the decade to 2030. The electricity demand response to price changes also provides abatement throughout the projection period, though abatement from this source is smaller than that from the change in the composition of generation.

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Chart 3.2: Electricity emissions, 2010 to 2030

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Source: Estimates from MMRF based on ACIL Allen Consulting.

Transformation of the electricity sectorIn the policy scenarios, a carbon price drives changes in the mix of technologies and fuels used in the electricity sector. Australia has a range of technological options available including gas, wind, solar and geothermal resources. Nuclear power is assumed not to be available, and carbon capture and storage does not come on stream until 2030 in the high price scenario, and later in other scenarios.

In the central policy scenario, the combination of the Large-scale Renewable Energy Target (LRET) and carbon pricing makes gas and renewable energy sources more competitive relative to coal, leading to a progressive transition from conventional coal-fired generation. Coal-fired electricity declines as a share of total generation across all scenarios after carbon is priced. Gas-fired electricity plays a more important role in delivering baseload generation with carbon pricing than in the no carbon price scenario, but rising gas prices over time in all scenarios limit the expansion of the sector. In the high carbon price scenario, there is faster transformation of the electricity generation sector, with gas and renewables together contributing over 83 per cent of the generation mix by 2030.

This transformation of the fuel and technology mix reduces the emissions intensity of electricity supply. The emissions intensity of generation in the high price scenario is projected to decline around 70 per cent by 2030 compared with current levels.

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Chart 3.3: Emissions intensity of electricity generation

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Chart 3.4: Sources of electricity generation Central policy scenario No carbon price scenario

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The increase in renewables driven by the LRET satisfies most growth in demand to 2020 in the central policy and no carbon price scenarios. Renewable generation reaches 23 per cent of total generation by 2020 in the central policy scenario and 24 per cent of total generation by 2020 in the high price scenario. This includes renewable generation driven by the Small-scale Renewable Energy Scheme (SRES). The relatively small additional increase in renewable generation in 2020 in the central policy scenarios is a result of partially offsetting movements in the modelled prices of renewable energy certificates.

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Chart 3.5: Renewables by technology — share of total generationCentral policy scenario

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Renewable generation continues to grow to 2030 in the central policy scenario, to around 26 per cent of total generation. In the high price scenario, the uptake of renewable generation after 2020 is much stronger, reaching 69 per cent and replacing the majority of coal-fired generation by 2030.

The early increase in renewables is largely driven by increased wind generation. However, over time, other renewables become increasingly competitive. In the high carbon price scenario, substantially higher levels of geothermal come on stream after 2020.

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Electricity demand and prices Overall, electricity consumption is lower in the scenarios with higher carbon prices. This occurs through households and firms moving towards lower levels of electricity use in consumption and production in response to higher electricity prices, and through restructuring of the economy towards less electricity-intensive industries. This is offset partly by the uptake of electric vehicles, which has a small impact on electricity demand by 2030. Compared to the no carbon price scenario, electricity demand is around 3 per cent lower in the central policy scenario in 2020 and around 7 per cent lower in the high carbon price scenario.

Wholesale electricity prices rise over time even in the no carbon price scenario, driven by rising gas prices and the capital costs associated with new plants entering the market to meet growing demand. Carbon pricing flows through into electricity prices, increasing wholesale electricity prices by around $10 per MWh on average over the first five years relative to the no carbon price scenario. The deployment of lower emissions and higher cost technologies over time sees electricity prices continue to increase to 2030.

Wholesale electricity prices are sensitive to assumptions about energy commodity prices and capital costs. Changes in the prices of coal and gas have an immediate impact on electricity prices. In contrast, changes in the capital costs of new generators have a greater impact over time, as new generation capacity is required. Wholesale prices are only a portion of retail costs and, as such, changes in wholesale prices flow through to smaller percentage changes in retail prices.

Chart 3.6: Electricity demand

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Chart 3.7: Average wholesale electricity prices

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Box 3.3: Domestic fuel price assumptionsThe modelling incorporates assumptions about the future path of coal, oil and gas prices. International prices for oil and gas are based on projections from the International Energy Agency 2012 World Energy Outlook (IEA 2012a), and coal prices are based on Treasury’s medium-term projections, informed by stakeholders and domestic and international experts. These figures are converted to Australian dollars based on projected exchange rates.

Long-run coal prices are projected to be higher than those presented in the Strong growth, low pollution (SGLP) report (Australian Government 2011). Following falls in coal prices in mid-2011, on the back of weak demand and increased world supply in international markets, prices are projected to stabilise over the next five to ten years.

Over recent years, oil prices have risen and are projected to remain at elevated levels. Recent strength in the level of oil prices, relative to other fuels, is driving a worldwide structural shift in fuel use with substitution towards cheaper alternative fuels.

The modelling incorporates assumptions regarding Australian netback gas prices, which are derived from international gas prices. Netback prices can be considered ‘wellhead prices’, and are formulated as a proportion of market prices. This proportion represents the costs of bringing the commodity to market and can include, but are not limited to, liquefaction, pipeline and shipping transportation, royalties and import duties. ACIL Allen Consulting provided estimates of costs associated with LNG production to inform gas netback price assumptions.

Chart 3.1: Domestic fuel prices

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Source: IEA (2012a), Australian Government (2011) and ACIL Allen Consulting.

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3.2.2 Direct combustionDirect combustion emissions arise from the combustion of fuels for energy used directly, in the form of heat, steam or pressure. Direct combustion emissions arise in all sectors of the economy, including agriculture, mining, manufacturing, services and residential sectors. The two main sources are the manufacturing and mining industries, which together contribute around three-quarters of all direct combustion emissions. Within the mining sector, oil and gas extraction and particularly the production of LNG is the largest source, contributing around 20 per cent of direct combustion emissions in 2012. Within the manufacturing sector, non-ferrous metal manufacturing, particularly alumina production, is the largest source, contributing 12 per cent of direct combustion emissions in 2012.

Direct combustion emissions accounted for around 95 Mt CO2-e in 2012, or around 16 per cent of Australia’s total domestic emissions. The oil and gas extraction industry has been the largest contributor to growth in direct combustion emissions since 2000, due in part to growth in LNG production for export.

Chart 3.2: Direct combustion emissions, 2000 to 2030

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Direct combustion emissions are projected to grow to 116 Mt CO2-e in 2020 and 125 Mt CO2-e in 2030 in the central policy scenario. Emissions from the mining industry are projected to rise by 22 Mt CO2-e between 2012 and 2020. Much of this growth is a result of the development of the LNG industry, with seven new projects, all of which have taken final investment decisions, expected to commence production during this period.

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Manufacturing sector emissions are projected to decline over the period to 2020, with emissions falling by 3 Mt CO2-e between 2012 and 2020. Some of this change is due to declining production. For example, petroleum refining volumes are projected to contract due to competitive pressure from larger international refineries, and the projections incorporate announced closures. Emissions from other manufacturing sectors are also projected to fall slightly due to declining emissions intensity of production.

Compared with the no carbon price scenario, carbon pricing is projected to reduce direct combustion emissions by 4 Mt CO2-e by 2020 in the central policy scenario. Abatement is projected to grow in the longer term as new infrastructure investments incorporate low-emissions technologies in response to a carbon price and the structure of the economy moves towards production of less emissions-intensive goods and services.

3.2.3 Transport The transport sector covers emissions from the direct combustion (or end-use emissions) of fuels by road, rail, domestic aviation and domestic shipping. Emissions from domestic air, rail and water transport are covered by the carbon price and the modelling assumes emissions from heavy on-road transport are covered by an equivalent carbon price from 2014-15.

Transport emissions were 91 Mt CO2-e in 2012, contributing 15 per cent of Australia’s total domestic emissions. Road transport was the largest subsector with emissions of 77 Mt CO2-e, contributing 84 per cent of total transport emissions in 2012, followed by domestic aviation, which contributed around 8 per cent of transport emissions or 7 Mt CO2-e in 2012.

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Chart 3.3: Transport emissions, 2000 to 2030

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Transport sector emissions are driven primarily by economic activity, population growth and oil prices. Improvements in vehicle technology, such as fuel efficiency and engine design standards, also play a significant role, as do consumer preferences such as changes in the fleet mix, and modal switching (for example between road and air transport). Activity levels in rail and shipping have been driven primarily by bulk commodity production.

Transport activity growth continues in the central policy scenario. Freight activity is projected to grow with economic activity, while private transport growth is lower due to saturation effects as household incomes rise. Despite this growth, emissions in the transport sector remain relatively flat. The fall in emissions intensity is due largely to ongoing fuel efficiency improvements in all scenarios and fuel switching driven by the carbon price in the central policy scenario. Growth in activity remains similar across most sectors, although there is some substitution from road transport to rail. Domestic air transport is slightly higher in the central policy scenario than in the no carbon price scenario as the lower real exchange rate encourages tourism.

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Chart 3.4: Transport emissions by mode, 2012 to 2030Central policy scenario

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Chart 3.5: Transport activity and emissionsActivity growth from 2012 to 2030 Emissions growth from 2012 to 2030

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The carbon price leads to a fall in emissions intensity for all transport sectors relative to the no carbon price scenario by driving changes in fuel use. Transport delivers about 9 per cent of total domestic abatement out to 2030 in the central policy scenario with the road transport sector providing the majority of abatement. Road transport is projected to deliver 4 Mt CO2-e of abatement due to the carbon price in 2020 and 12 Mt CO2-e of abatement in 2030, relative to the no carbon price scenario. Abatement is limited in the near term by the time required to turn over the vehicle fleet and the higher upfront costs of cleaner

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technologies. However, after 2020, the carbon price accelerates the uptake of hybrids and electric vehicles.

Chart 3.6: Road fuel mix, central policy scenarioHeavy freight vehicles Light commercial vehicles

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Note: Biodiesels are B20, pure biodiesel and biomass-to-liquid. Synthetic diesels are coal-to-liquid, shale-to-liquid and gas-to-liquid.Source: CSIRO.

In the heavy road freight vehicle sector, the most significant change in fuel mix is the adoption of liquefied or compressed natural gas (LNG or CNG) and biodiesel. There is also an uptake of electric vehicles, although these remain fairly small shares of the overall mix. Despite the adoption of lower emissions fuel types, emissions from trucks in 2030 are around 12 per cent higher than 2012 levels, due to the increase in freight activity.

Changes in transport fuels and technologies driven by heavy vehicle demand are also projected to have spill over effects on light commercial vehicle users (as well as private transport). This in part drives fuel switching to biodiesel. After 2022, a significant switch to synthetic diesels is projected. Emissions from light commercial vehicles in 2030 are 14 per cent below 2012 levels.

The policy of applying an equivalent carbon price to heavy on-road transport from 2014-15 has not yet been legislated. A sensitivity analysis was undertaken to look at the effects on emissions of this proposed policy change. In the absence of coverage of heavy on-road transport, domestic emissions would be higher by 4 Mt CO2-e in 2020 and by 12 Mt CO2-e over the period from 2013 to 2020. By 2030, domestic emissions would be 11 Mt CO2-e higher than in the central policy scenario.

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Air, rail and water transportDomestic aviation, domestic shipping and rail together account for less than 1 Mt CO2-e of abatement in 2020 and 3 Mt CO2-e of abatement in 2030, mainly due to fuel switching in domestic aviation.

Biofuels are projected to represent the best opportunity for decreasing emissions in the aviation sector. A shift from petroleum-based jet fuel towards bio-derived jet fuel is projected to occur after 2025. This shift is driven by increased availability of biofuels and decreased production costs for bio-derived jet fuel, as well as a shift toward fully or partially electrified vehicles in the road sector which reduces growth in liquid fuel demand from road vehicles.

The carbon price drives a shift from fuel oil to diesel as the main fuel source for shipping. Abatement in the rail sector is slow as infrastructure is slow to turn over, but substitution of diesel with biodiesel and natural gas is projected to drive a modest reduction in emissions intensity to 2030.

3.2.4 FugitivesThe fugitives sector covers emissions associated with the production, processing, transport, storage, transmission and distribution of fossil fuels such as black coal, oil and natural gas. Emissions from decommissioned underground coal mines are also included in this sector. The fugitives sector does not include the emissions arising from the combustion of these fuels; these emissions are accounted for under the stationary energy and transport sectors. A key driver of fugitive emissions is growth in the production of coal, oil and natural gas, which is influenced strongly by export demand. Fugitive emissions were 48 Mt CO2-e in 2012, or around 8 per cent of Australia’s total domestic emissions, of which 34 Mt CO2-e were associated with coal mining and 14 Mt CO2-e with oil and gas extraction.

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Chart 3.7: Fugitive emissions, 2000 to 2030

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Coal fugitive emissions are projected to grow to 46 Mt CO2-e in 2020 in the central policy scenario. Production of black coal grows strongly over the next few years in response to sustained high export demand, primarily from China and India, notwithstanding global action to reduce emissions. Australian coal plays a role in meeting China’s increasing demand, which is projected to peak around 2020. After 2020, growth in coal production is slower in all scenarios due to the higher international carbon price and greater Chinese integration into international carbon markets.

The carbon price is projected to achieve 11 Mt CO2-e of domestic abatement in the coal fugitive sector in 2020. The carbon price reduces fugitive coal emissions by encouraging a relative expansion of less gassy mines and the deployment of technologies to capture fugitive emissions, which become increasingly available over the projection period. Pre-2020, indirect abatement systems such as pre- and post-mine drainage are projected to reduce emissions, especially where there are opportunities for co-benefits such as electricity generation. Flaring of waste mine methane is projected to become common practise amongst mines employing drainage. After 2020, technological advances are projected to support the application of pre-mine drainage to complex deep seam, multi-seam and low permeability mines that are not accessible with surface drilling. Direct abatement systems such as the capture and use of ventilation air methane are projected to become widespread in Australian coal mines in the next five to ten years under a carbon price.

In 2020, oil and gas fugitive emissions are projected to grow to 19 Mt CO2-e in the central policy scenario. Emissions from the subsector increase over the projection period due to strong growth in the production of natural gas, particularly LNG. The carbon price is projected

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to achieve 3 Mt CO2-e of domestic abatement in the oil and gas fugitive sector in 2020 through equipment upgrades and reduced transmission losses.

3.2.5 Industrial processesThe industrial processes sector encompasses emissions generated from a range of production processes in metal production (32 per cent), mineral production (19 per cent), the chemical industry (18 per cent), consumption of halocarbons and sulphur hexafluoride (30 per cent), and other production (1 per cent).

Carbon dioxide emissions are produced from clinker and lime production; from limestone and dolomite use; ammonia production; other chemical production; and aluminium, steel and other metal smelting. Methane emissions are produced from steel smelting and chemical production, nitrous oxide emissions from nitric acid production and perfluorocarbons from aluminium smelting.

Synthetic greenhouse gas emissions (hydrofluorocarbons, perfluorocarbons and sulphur hexafluoride) are produced from refrigeration and air-conditioning equipment, foam blowing, fire extinguishers, solvents, metered dose inhalers and other electric equipment.

In 2012, industrial processes sector emissions accounted for around 32 Mt CO2-e in 2012, around 5 per cent of Australia’s total domestic emissions.

Chart 3.8: Industrial processes emissions, 2000 to 2030

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Industrial processes emissions are projected to decline to 27 Mt CO2-e in 2020 in the central policy scenario primarily through a decline in

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emissions intensity in each industry. In the central policy scenario, around 10 Mt CO2-e of abatement is achieved in the industrial processes sector in 2020. The biggest sources of abatement are expected to be the implementation of nitrous oxide conversion catalysts in chemical production; substitution to less emissions-intensive input materials in metal and mineral production; and the replacement and destruction of halocarbon refrigerants.

The projections incorporate a transition towards lower production capacity in Australia’s aluminium smelting sector. In the chemical industry, production increases as ammonium nitrate plants are built and expanded to produce explosives (for use in mining) and fertiliser. In the cement industry, increased importation of clinker is projected to limit the expansion of domestic production and emissions.

Halocarbons and sulphur hexafluoride are covered under an equivalent carbon price. These synthetic greenhouse gases are not made in Australia — they are imported. Emissions arise from the leaking of these gases into the environment. Abatement is projected through recovery and destruction of synthetics at the end of the lifetime of appliances under the Destruction Incentives Program, and replacement with less emissions-intensive refrigerants. In the central policy scenario, 4 Mt CO2-e of abatement is achieved in this subsector in 2020.

3.2.6 WasteThe waste sector includes emissions from landfills; domestic, commercial and industrial wastewater treatment; waste incineration; and the biological treatment of solid waste. Emissions consist largely of methane, which is generated when organic matter decays under anaerobic conditions. Waste sector emissions accounted for around 15 Mt CO2-e in 2012, or about 3 per cent of Australia’s total emissions.

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Chart 3.9: Waste emissions, 2000 to 2030

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Waste emissions are projected to decline to 12 Mt CO2-e in 2020 in the central policy scenario.

The main drivers of emissions from the solid waste subsector are population growth, increasing waste generation per person, and waste diversion and methane capture rates. In the wastewater subsector key drivers are population growth, growth in industrial production and methane capture rates.

Emissions from solid waste are projected to decrease over time in the central policy scenario due to improvements in methane capture rates and waste diversion, which more than offset the effects of population growth and increased waste generation per person. Wastewater emissions are also projected to decrease over the projections period due to increased methane capture in response to the carbon price.

The carbon price and CFI are projected to achieve 3 Mt CO2-e of abatement in 2020 in the central policy scenario. The biggest sources of abatement in the waste sector are projected to be methane capture for electricity generation or flaring, and the diversion of waste from landfill to recycling and composting facilities. Diversion of waste to biological treatment facilities reduces overall waste emissions, but increases emissions from the biological treatment of solid waste by two-thirds over the period to 2030.

Abatement of emissions from legacy waste is eligible for CFI credits. The CFI is projected to drive a steep reduction in legacy emissions in the early years of the projections period. The abatement achieved through the CFI in the waste sector is projected to decline from 2015 as legacy waste emissions decline. Non-legacy emissions abatement achieved by the carbon price continues to increase across the projections period.

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3.2.7 AgricultureThe agriculture sector includes emissions from enteric fermentation, manure management, rice cultivation, agricultural soils, prescribed burning of savanna and field burning of agricultural residues. It does not include emissions from fuel combustion from operating equipment, which are included in the stationary energy sector, or cropland and grazing land management, which are in LULUCF. In 2012, agriculture emissions accounted for 100 Mt CO2-e, 17 per cent of Australia’s total emissions.

Chart 3.10: Agriculture emissions, 2000 to 2030

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Agriculture emissions are projected to grow to 103 Mt CO2-e in 2020 in the central policy scenario. Enteric fermentation from livestock is the main agricultural emissions source (over 65 per cent of agricultural emissions), with beef cattle the largest contributor. Projected international demand for beef, which in turn drives the domestic cattle herd size, is the main factor influencing agricultural emissions. Global income growth, particularly in South-East Asia, is projected to lead to increased demand for Australian exports.

Agriculture emissions are not covered by a carbon price and abatement is driven by the CFI. The CFI is projected to achieve 3 Mt CO2-e of domestic abatement in 2020 in the central policy scenario, primarily through reduced emissions from livestock (such as capturing methane from manure ponds) and improved savanna fire management practices.

3.2.8 Land use, land-use change and forestry (LULUCF)The LULUCF sector includes emissions and removals from deforestation, afforestation and reforestation activities. From 2013, emissions and removals from forest management, cropland management, grazing land

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management and revegetation are also reflected in the LULUCF sector. These new subsectors have been added to reflect the new scope and coverage of Australia’s emissions in the second commitment period.

In 2012, emissions from the LULUCF sector accounted for 21 Mt CO2-e, 4 per cent of Australia’s total emissions. The two largest subsectors of the LULUCF sector, deforestation and reforestation account for 47 Mt CO2-e and -25 Mt CO2-e of emissions and removals respectively. Annual rates of land clearing have decreased substantially since 1990 with consequent reductions in estimated emissions.

Chart 3.11: Land use and land-use change emissions, 2000 to 2030

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Chart 3.12: Forestry emissions, 2000 to 2030

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LULUCF emissions are projected to be 18 Mt CO2-e in 2020 in the central policy scenario. The key drivers of LULUCF emissions and removals are

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government regulations restricting land clearing, and economic conditions in the agricultural and forest sectors. After a slowdown in deforestation from stricter Queensland land clearing laws, easing of these laws through the Vegetation Management Framework Amendment Act 2013 (Qld) means land managers are now less likely to require a permit to undertake land clearing activity. Upward pressure on land clearing activity could be expected particularly to the extent that there is excess demand in the farm sector that could be met through an increase the area of land under production. Deforestation levels are projected to stabilise at a level of around 50 Mt CO2-e per year, assuming no significant changes to land clearing regulations and a balance between growth and harvesting of plantation estates.

Key drivers for removals from reforestation activities include the size of plantation forest estates, past rates of plantation establishment, and harvesting rates. The removals result when carbon is sequestered by forest plantations growing on this land. The projections assume slow growth in the total area of forest plantations to 2030. The high exchange rate has made exporting plantation products more challenging in recent years and economic conditions are projected to remain subdued. New plantation establishment is projected to continue at historically low rates, while in some cases plantation land will be converted to agricultural use following final harvest rather than being re-planted.

The carbon pricing mechanism does not cover LULUCF activities. However, the CFI provides farmers, land-owners and plantation managers with the opportunity to create credits for Kyoto-compliant land sector activities. The CFI is projected to achieve 12 Mt CO2-e of domestic abatement in the LULUCF sector in 2020 in the central policy scenario. Avoided deforestation (4 Mt CO2-e) and forest management practices (3 Mt CO2-e) are the largest contributors to this CFI abatement.

Forest management emissions are projected to remain at low levels due to continued historically low harvesting rates in native forests. This decline has been associated with changes in supply factors such as increasing supply from plantations. Demand factors such as the international price of harvested wood products, the value of the Australian dollar and shifts in demand patterns, especially between Japan and China, have also contributed to the decline in harvesting.

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Box 3.4: Abatement from the Carbon Farming Initiative The reduction in domestic emissions achieved in the policy scenarios, as described above, is delivered partly through the application of a carbon price (or equivalent) to emissions from a range of sources, and partly through the CFI. The CFI provides an incentive for emissions reductions in the LULUCF and agriculture sectors, and the waste sector for legacy waste. These sectors are not covered by the carbon price. In the central policy scenario, CFI abatement is estimated to be 16 Mt CO2-e, in 2020, rising to 20 Mt CO2-e in 2030. The biggest sources of abatement are projected to be from avoided deforestation and forest management activities, which are included within the LULUCF sector. Further details on projected CFI abatement are in Appendix C.

Chart 3.1: Abatement from the CFI by sectorCentral policy scenario

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3.3 Covered emissionsUnder the carbon pricing mechanism, entities that emit greenhouse gases that are covered by the scheme attract a liability. Covered emissions are those that attract a liability under the carbon pricing mechanism as well as those under an equivalent carbon price. Direct coverage includes emissions from stationary energy, industrial processes, fugitive emissions (other than from decommissioned coal mines), and emissions from non-legacy waste. An equivalent carbon price is applied to some transport fuels and importation of synthetic greenhouse gases. Overall, this covers around two-thirds of Australia’s emissions directly and through other means. Emissions from agriculture, deforestation and reforestation are not covered by the carbon price or an equivalent carbon price, but the CFI provides a link to the carbon price by allowing these sectors to create offset units to trade into the compliance market.

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The projections indicate that net covered emissions will decline as the carbon pollution cap binds. Total covered emissions—under the mechanism and through effective carbon pricing— net of international abatement are projected to reach 352 Mt CO2-e in 2020 and 194 Mt CO2-e in 2030 in the central policy scenario. After the inclusion of heavy road vehicles under the carbon price, the level of uncovered emissions are projected to remain relatively stable in the absence of new policies, with declines over time in legacy emissions in waste and synthetic greenhouse gases and light vehicle transport offset by growth in agriculture sector emissions.

Chart 3.2: Covered and uncovered emissions, 2013 to 2030Central policy scenario

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Note: Net covered emissions are emissions covered directly by a carbon price and through an effective carbon price, less abatement sourced overseas.Source: Estimates from MMRF.

3.4 Economic effects in alternative price scenariosThe economic effects of carbon pricing vary with the level of the carbon price and the level of the emissions cap. The level of the carbon price determines the extent of transformation of the emissions intensity of production within industries and the industry structure of the economy, which tends to reduce national production and income compared to their levels in the absence of carbon pricing. While this process reduces domestic emissions, for a country like Australia with a rapidly growing economy and relatively cheap fossil fuels, it would be more expensive to meet the whole abatement task through domestic abatement. Buying international carbon permits allows Australia to run a higher level of domestic emissions while achieving a particular net emissions target. However, buying international permits involves transferring income overseas, which tends to reduce national income compared to a scenario

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with no carbon pricing. In all scenarios, these effects are small compared with the ongoing growth in GDP and GNI per person over time.

The high price scenario is set in a world taking more ambitious action than the other scenarios. Differences in economic outcomes in that scenario, compared with the other three scenarios, partly reflect the effects of action domestically and partly the effects of international action on Australian trade flows.

3.4.1 Economic growthThe alternative carbon pricing scenarios present only modestly different economic outlooks. In each of the scenarios, GDP continues to grow, to be more than 65 per cent larger in 2030 than it was in 2012. Over the period from 2012 to 2030, the average annual rate of GDP growth is 2.9 per cent in the central policy scenario compared with 3.0 per cent in the no carbon price scenario.

Chart 3.3: Gross domestic productLevel Change from no carbon price scenario

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Carbon pricing affects factors of production, such as labour and capital, in different ways. The size of the capital stock depends upon the rate of return available on investment. Higher carbon prices increase the cost of constructing and running some capital equipment, which reduces slightly firms’ incentives to invest in capital, and also reduces the rate of growth of some emissions-intensive sectors, which are typically more capital-intensive than the rest of the economy.

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Chart 3.4: Capital stockLevel Change from no carbon price

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Higher carbon prices also affect the demand for labour, as a result of slower output and capital growth. Household choices around their level of labour force participation are assumed not to change, so the level of employment is largely unaffected. Real wages grow more slowly in the scenarios with higher carbon prices.

Chart 3.5: Real wagesLevel Change from no carbon price scenario

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Higher or lower carbon prices would also affect the composition of the Australian economy. Over time, higher prices would see resources shift from emissions-intensive to low or less emissions-intensive industries. At

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the broad sectoral level, structural changes due to higher or lower carbon prices would be small compared to other ongoing changes in the economy. Some sectors, such as mining and construction, grow more slowly with carbon pricing. However, these effects are small compared to the difference in underlying growth trends between sectors, or compared with variation in underlying growth rates within sectors from one decade to the next. Sectors grow at similar rates in all scenarios.

Chart 3.6: Output growth by broad sector, 1990 to 2030Annual average growth

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Much of the effect of carbon pricing on the structure of the economy is through the transition of resources between different industries within the same sector. Relative carbon intensity affects how industries respond to pricing carbon. Responses also differ to changes in assumptions about global ambition, which affect export demand for Australian energy through changes in carbon prices in Australia and overseas, and changes in assumptions about domestic prices alone.

For example, within mining, some sectors, such as iron ore mining, grow faster with a higher domestic carbon price. Energy extraction industries, particularly coal mining, grow less quickly than they otherwise would. While domestic pricing of fugitive emissions in coal mining reduces somewhat production in the industry, the extent of international action to reduce emissions has a larger effect, as is evident in the high price scenario. Coal production grows steadily throughout the period in all scenarios set against a backdrop of medium global action. In the high price scenario with a backdrop of more ambitious global action, however, coal production grows over the period to 2020 but is flat through the decade to 2030. Note that internationally, as presented in Chapter 2, carbon capture and storage is projected not to be installed prior to 2030.

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Table 3.1: National economic indicatorsAt 2000 At 2010 At 2012

Emissions target Change from 2000 level, per cent -5 -5 -25 -80 -80 -80Domestic emissions, Mt CO2-e 586 590 600 685 651 620 551 801 672 644 465 Change from no carbon price scenario, Mt CO2-e - - - - 35 65 134 - 129 156 335 Change from 2000 level, per cent - 1 2 17 11 6 -6 37 15 10 -21Internationally-sourced abatement, Mt CO2-e - - - - 96 65 114 - 263 236 135Emissions intensity of GDP, kg CO2-e/$ 0.57 0.42 0.41 0.36 0.35 0.33 0.30 0.32 0.27 0.26 0.19Emissions per person, t CO2-e per person 31 26 26 26 25 24 21 26 22 21 15Carbon price, real, $/t CO2-e - - 0 6 30 73 0 54 54 134GNI per person, $ '000 45.9 57.7 62.3 66.7 66.6 66.5 65.8 73.3 72.3 72.1 70.1 Average annual grow th, per cent per year - - - 0.8 0.8 0.8 0.7 0.9 0.8 0.8 0.7GDP, $ '000 billion 1.030 1.392 1.475 1.882 1.880 1.877 1.866 2.510 2.491 2.483 2.446 Average annual grow th, per cent per year - - - 3.1 3.1 3.1 3.0 3.0 3.0 2.9 2.9Employment, million people 8.9 11.0 11.5 12.9 12.9 12.9 12.9 14.7 14.6 14.6 14.6

Household consumption per person, - - - 1.2 1.2 1.2 1.0 0.9 0.9 0.8 0.7

average annual grow th, per cent per yearReal w ages, - - - 1.4 1.4 1.3 1.2 0.9 0.8 0.8 0.5

average annual grow th, per cent per yearCapital stock, - - - 4.7 4.7 4.7 4.6 4.3 4.2 4.2 4.1

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At 2020 At 2030Central policy

No carbon price Low price High price

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Note: All dollar values are in Australian dollars at 2012 prices. Annual growth rates are from 2012. Emissions intensities relate to domestic emissions only. Domestic emissions reductions associated with GreenPower of around 2 Mt CO2-e per year are in addition to the stated emissions target.Source: ABS, National Greenhouse Gas Inventory; projections from MMRF.

Chapter

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an projections

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Chart 3.7: Energy extraction industriesCoal production Gas production

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Within manufacturing, the effects of carbon pricing depend upon the level of assistance provided to emissions-intensive industries through the Jobs and Competitiveness Program, and the responsiveness of the sectors to changes in the real exchange rate. Many emissions-intensive industries receiving assistance are projected to grow as fast to 2020 in the central policy scenario as in the no carbon price scenario, but grow slower after assistance is assumed to be phased out in the first half of the 2020s. Over time, employment and investment flows into less emissions-intensive manufacturing sectors which become more competitive. Industries like textiles, clothing and footwear and motor vehicles and parts grow a little faster in the central policy scenario than in the no carbon price scenario.

Comparisons between the central policy scenario and the high price scenario are more complex. The latter makes the modelling assumption that the world takes more ambitious action, without assistance to emissions-intensive industries in other countries. This tends to push up production costs and world prices for emissions-intensive goods. In the near term, this scenario would tend to increase the competitiveness of some Australian industries—such as steel and petroleum refining—and in the long term the effect on competitiveness depends on how the emissions intensities of production in Australia compared to competitors in other countries.

Agricultural activity emissions are assumed to be excluded from carbon price coverage, but abatement occurs through the CFI. Overall, agricultural output tends to grow at a similar rate in all scenarios.

Construction activity follows the level of investment in the capital stock overall and is lower in the scenarios with higher carbon prices, as is the

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Chapter

3: Australi

an projections


output of the cement industry, which provides the construction sector with intermediate inputs.

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Table 3.2: Gross output, by industry, 2020

Industry No carbon price Low price Central policy High pricePer cent Per cent Per cent Per cent

Agriculture 15 15 15 16Sheep and cattle 20 20 20 20Dairy cattle 17 17 17 18Other animals 23 25 25 26Grains 1 1 1 2Other agriculture 23 23 23 24Agricultural services and fisheries 18 18 19 20

Mining 60 60 59 59Coal 58 57 55 53Oil 1 1 1 1Gas 95 95 95 95Iron ore 71 71 71 73Non-ferrous ore 60 60 59 59Other 32 32 32 33

Manufacturing 0 0 0 0Meat products 21 21 21 22Other food 11 11 11 12Textiles, clothing and footw ear -12 -12 -12 -9Wood products 10 10 10 11Paper products -1 -1 -1 0Printing 12 12 12 12Refinery -25 -26 -26 -24Chemicals -21 -21 -21 -21Rubber and plastic products -6 -6 -6 -6Non-metal construction products 8 8 8 7Cement 8 8 7 6Iron and steel -7 -7 -7 -5Alumina 27 28 30 25Aluminium -17 -17 -16 -17Other metals -9 -9 -8 -16Metal products 5 5 5 5Motor vehicles and parts -13 -13 -13 -11Other -5 -5 -5 -4

Construction 38 37 37 35Services 28 28 28 27

Electricity: coal-f ired 3 -2 -7 -36Electricity: gas-fired -23 -18 -11 54Electricity: hydro 1 4 5 5Electricity: other 210 215 222 263Electricity supply 13 11 9 5Gas supply 36 36 37 40Water supply 15 14 14 14Trade 22 22 21 21Accommodation and hotels 18 17 17 16Road transport: passenger 21 21 21 20Road transport: f reight 26 26 26 25Rail transport: passenger 26 26 27 29Rail transport: f reight 55 55 55 55Water transport 24 24 24 24Air transport 34 34 33 33Communication 40 40 40 39Financial 35 35 35 34Business 40 40 40 40Public 21 21 21 20Other 23 23 23 21

Change from 2012


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Table 3.3: Gross output, by industry, 2030

Industry No carbon price Low price Central policy High pricePer cent Per cent Per cent Per cent

Agriculture 54 54 54 54Sheep and cattle 43 43 42 44Dairy cattle 31 32 32 33Other animals 56 58 58 61Grains 30 30 29 27Other agriculture 83 84 84 84Agricultural services and fisheries 89 91 91 93

Mining 98 97 96 92Coal 86 81 79 50Oil 2 2 2 2Gas 128 127 127 123Iron ore 139 141 143 152Non-ferrous ore 106 106 104 109Other 57 58 58 61

Manufacturing 27 27 26 28Meat products 63 65 65 68Other food 43 44 44 46Textiles, clothing and footw ear 24 27 28 39Wood products 57 56 55 60Paper products 28 28 28 31Printing 53 54 54 55Refinery -17 -21 -22 -22Chemicals -15 -17 -17 -14Rubber and plastic products 18 18 18 21Non-metal construction products 41 41 40 43Cement 22 18 17 13Iron and steel -5 -10 -11 -11Alumina 77 57 52 25Aluminium 17 -5 -22 -46Other metals -3 -3 -3 -5Metal products 35 34 33 32Motor vehicles and parts 30 32 32 38Other 30 31 31 37


Electricity: coal-f ired 32 8 -1 -70Electricity: gas-fired -28 1 6 3Electricity: hydro 5 10 6 6Electricity: other 315 373 362 1154Electricity supply 39 33 27 21Gas supply 61 61 62 58Water supply 39 38 38 37Trade 65 64 63 62Accommodation and hotels 43 41 41 38Road transport: passenger 44 43 43 40Road transport: f reight 79 79 78 79Rail transport: passenger 45 51 53 67Rail transport: f reight 125 127 127 129Water transport 72 71 71 70Air transport 78 78 78 81Communication 112 110 110 107Financial 98 97 97 96Business 124 124 123 123Public 75 75 75 74Other 58 56 55 51

Change from 2012


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Table 3.4: Gross output, by sector, 2020Change from 2012

No carbon price Low price Central policy High pricePer cent Per cent Per cent Per cent

Agriculture 15 15 15 16Mining 60 60 59 59

Coal, oil & gas 65 64 63 62Other mining industries 57 56 56 57

Manufacturing 0 0 0 0High emissions-intensive manufacturing -9 -9 -9 -11Low emissions-intensive manufacturing 5 5 5 6


Source: Estimates from MMRF

Table 3.5: Gross output, by sector, 2030Change from 2012

No carbon price Low price Central policy High pricePer cent Per cent Per cent Per cent

Agriculture 54 54 54 54Mining 98 97 96 92

Coal, oil & gas 91 88 87 72Other mining industries 103 103 103 108

Manufacturing 27 27 26 28High emissions-intensive manufacturing 5 2 0 -1Low emissions-intensive manufacturing 42 43 43 46



3.4.2 Regional projectionsThe economies of all states are projected to grow. Differences in growth rates across states and industries reflect different assumptions about population growth and different patterns of industrial production. The expansion of the LNG industry will play an important role in Queensland and Western Australia, but not in other states, for example. The technical assumptions used to allocate national growth by state are described in Appendix A.

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Table 5.2: Growth in output by state and sectorChange from 2012 to 2030

No carbon price Central policy No carbon price Central policy No carbon price Central policyPer cent Per cent Per cent Per cent Per cent Per cent

Agriculture 50 49 53 53 55 56Mining 105 92 58 55 116 114Manufacturing 21 20 27 27 39 36Construction 63 59 80 77 106 102Services 81 80 83 82 97 95

No carbon price Central policy No carbon price Central policy No carbon price Central policyPer cent Per cent Per cent Per cent Per cent Per cent

Agriculture 58 60 51 51 65 65Mining -8 -12 116 116 101 95Manufacturing 28 29 31 27 15 13Construction 37 33 126 123 70 68Services 65 64 97 95 51 49

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The effect of carbon pricing on gross state product (GSP) depends upon the extent of abatement achieved within each state. This depends upon each state’s emissions intensity, which in turn depends on its industry structure, and the extent of reduction in emissions intensity achieved. To the extent the carbon price affects the exchange rate, the state’s trade intensity also matters.

Chart 5.1: Emissions intensity by stateCentral policy scenario

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Chart 3.1: Gross state product, central policy scenarioLevel Change from no carbon price scenario

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It is difficult to quantify the impact of carbon pricing at a sub-state regional level, or for relatively small economies such as the Northern Territory and Australian Capital Territory, due to limitations on the level and quality of data available. Over time, carbon pricing will encourage resources to move between regions, but reliable information on which to project these movements is not available.

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Box 3.5: Timing of the move to a flexible price The central policy scenario assumes a transition to a flexible price from 1 July 2014. Australia’s domestic emissions in 2014-15 are projected to be 609 Mt CO2-e and, with additional abatement sourced overseas, net emissions are 584 Mt CO2-e in that scenario.

A sensitivity analysis was undertaken to explore the effect of retaining the fixed price of $25.40 in 2014-15, as legislated as part of the Clean Energy Future plan. The higher carbon price means that more of Australia’s abatement task in that year would be achieved through domestic abatement. The modelling projects domestic emissions to be 598 Mt CO2-e in 2014-15. With more of the abatement task achieved through domestic emissions reductions, GDP is projected to be lower than in the central policy scenario by 0.03 per cent in that year. Changes in GNI would depend upon assumptions about how the difference between domestic and net emissions is addressed. In subsequent years, domestic emissions and GDP are projected to be essentially the same as in the central policy scenario.

3.4.3 Implications for national incomeReal income continues to grow in all scenarios. This section focuses on the effects of the alternative policy scenarios on real gross national income (GNI) per person, which is a measure of the volume of goods and services that Australians can buy with the income they generate from production and how those effects come about.

While GDP is a measure of the value of production in Australia and is the most common measure of the size of the economy, GNI is a better measure of welfare because it also accounts for that part of domestically generated income that accrues to non-residents, including that part required to pay for abatement sourced overseas. It also accounts for movements in the terms of trade, which is the price of the goods and services Australia exports relative to the price of imports.

Purchasing foreign permits involves a transfer of income from Australia to other countries. The income outflow leads to lower terms of trade and a lower exchange rate, further reducing income and welfare. The effect on GNI depends on the prevailing world carbon price and the exchange rate, as well as Australia’s national emissions trajectory. In a world where other countries pursue more ambitious abatement targets, the carbon price will be higher and this increases the cost in terms of domestic production and income forgone in achieving a given trajectory.

GNI per person is projected to grow around 0.8 per cent per year over the period to 2030 in the central policy scenario. This projected growth rate is below the rates achieved in the previous two decades of economic growth due to the assumed return of the terms of trade towards more sustainable long-run levels and the ageing of the population. It compares

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with projected growth in GNI per person of 0.9 per cent per year over the period to 2030 in the no carbon pricing scenario. The difference in rates of growth means that the level of GNI per person attained in the no carbon price scenario in 2030 is attained 24 months later in the central policy scenario.

Table 3.1: GNI per person Average annual growth


Per cent Per cent Per cent Per cent

2012 to 2020 0.8 0.8 0.8 0.7

2020 to 2030 0.9 0.8 0.8 0.6

Average, 2012 to 2030 0.9 0.8 0.8 0.7


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Box 3.6: Comparison of economic effects with previous modellingEstimates of the economic effects of carbon pricing are somewhat lower in the current report than in previous modelling (Australian Government 2011). There are a number of contributors to the changes including lower projections for the international carbon price consistent with achieving stabilisation of atmospheric concentrations at 550ppm in the long term, lower projections for emissions in the no carbon price scenario implying a reduction in the estimated abatement task in 2020, and access to cheaper international abatement up to the CER sub-limit over the period between 2015 and 2020.Table 3.1: Comparison of economic effects in 2020

Current report Strong grow th, low pollution

Australian carbon unit price, nominal $ 36 38Domestic abatement, Mt CO2-e 65 58GDP, change from no price scenario, per cent -0.31 -0.34Internationally-sourced abatement, Mt CO2-e 65 94GNI, change from no price scenario, per cent -0.34 -0.50

Government policy scenario compared w ith medium global action scenario

Central policy scenario compared w ith no carbon

price scenario

Note: CFI abatement was included in the medium global action scenario, but is not included in the no carbon price scenario.Source: Australian Government (2011) and estimates from MMRF.

3.5 Implications of alternative targetsThis section steps through, from a conceptual perspective, the key economic effects that would flow from changes in the levels of the caps, and then presents modelled estimates of the effects of alternative targets on GNI that take account of some of these economic effects.

3.5.1 Economic effects of alternative targetsA more ambitious emissions reduction target would require a reduction in the scheme cap. Reducing the level of the scheme cap involves reducing the number of carbon units sold by the Australian Government. The main economic effects will be an increase in the purchase of foreign permits and a reduction in Government revenue from permit sales. It is assumed that the price of Australian carbon units will move in line with the EUA price and the changes in the level of the Australian scheme cap will have no material impact on that price, so that there is no direct change in business demand for permits. That is, the direct economic effects of reducing the level of the scheme cap by one tonne CO2-e will be to increase foreign income outflows by the carbon price, and reduce Australian Government revenue by the carbon price.

In general, the effects on gross national income may be expected to be larger than the carbon price because the increase in foreign income

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outflows tends to lower the Australian terms of trade, and replacing forgone carbon revenue from alternative sources will typically carry additional welfare costs. These two effects are described in more detail below. Taken together, they suggest a rough rule of thumb that the welfare cost of reducing the level of the scheme cap by one tonne CO2-e and replacing the forgone revenue with other taxes is around 1.55 times the carbon price.

Foreign income flowsA reduction in the level of the scheme cap will increase foreign income outflows.2 These payments overseas will affect the balance of payments. Exports must be higher to generate the additional foreign currency and Australian firms will generally need to lower export prices in order to increase their share of world markets. This will tend to reduce the terms of trade, which flows through to an additional reduction in the real value of gross national income and welfare.

The decline in the terms of trade will also increase the price of tradable capital goods relative to the price of domestic production. This will tend to lower the rate of return on investment in the near term and lead to lower capital stocks and lower production in the long term, which further reduces incomes.

RevenueThe sale of carbon permits is a source of revenue for the Australian Government and reduction in the level of the scheme cap will reduce that revenue. One way to consider the economic costs of replacing lower permit sales revenue is to look at the typical costs associated with other general sources of revenue. An alternative response to lower revenue may be a reduction in spending or an increase in debt issuance that permits the revenue or expenditure response to be delayed; consideration of the economic effects of those options is, however, more difficult to quantify within economic models.

Taxes fund public services and transfer payments to improve the wellbeing of the Australian people as a whole, but by themselves generally result in some loss of economic efficiency. For example, a tax may reduce incentives for people to work or invest or induce them to alter their consumption patterns. This leads to losses in consumer welfare — an ‘excess burden’ of taxation — which can be expressed relative to the amount of revenue raised. An efficient tax system involves taxes that result in relatively low losses in consumer welfare per dollar of revenue raised.

There is a range of uncertainty around the size of the excess burden of individual taxes and there are also likely to be significant differences 2 As the ABS has not finalised its accounting treatment of the purchase by Australians of

foreign permits; the treatment here is the same as that used in Australian Government (2008, 2011).

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between different taxes. Reasonable estimates suggest that the marginal excess burden of taxation is typically around 25 per cent. This is broadly in line with the estimates by KPMG-Econtech (2010), in work commissioned in support of the Australia’s Future Tax System Review, of the marginal excess burden of labour income tax, the single largest source of revenue. It is also consistent with the weighted average of the estimated marginal excess burdens across all Australian taxes that KPMG-Econtech modelled, though the estimates for individual taxes range from -8 per cent to +92 per cent. Such an assumption is also consistent with advice in the Department of Finance and Administration’s (2006) Handbook of Cost Benefit Analysis.

3.5.2 Modelling of alternative targetsThis section presents estimates of the welfare effects, measured by real gross national income, of changing scheme caps based on MMRF model simulations that incorporate general equilibrium effects of higher foreign income outflows, but not the excess burden associated with alternative revenue sources.

Regarding revenue, a standard modelling assumption is maintained that differences in government revenue associated with higher or lower carbon prices, or tighter or looser national trajectories, are returned to households as lump sum transfers. An alternative modelling approach would have been to assume the change in revenue is made up through changes in some other taxes, in which case the welfare costs associated with revenue collection would also have been modelled; this approach was not taken because such an assumption would necessarily have been arbitrary. The assumed marginal excess burden of taxation of 25 per cent would be in addition to the effects on GNI modelled here.

Under the central policy scenario, scheme cap levels that are consistent with abatement targets in 2020 of 5, 15, and 25 per cent below 2000 levels were modelled. Modelling results are consistent with a linear relationship between abatement targets and real GNI impacts throughout the period of 2015 to 2020. They suggest that reducing the cap by an additional tonne is associated with a change in GNI of around 1.3 times the carbon price.

These estimates reflect the production and trade structure of the MMRF model. Alternative models produce different estimates—with lower (or higher) estimates coming from models that have more (or less) elastic export demand and supply, and the elasticity of substitution between labour and capital also plays a role. Equivalent simulations within other models such as GTEM, the International Monetary Fund’s Global Integrated Monetary and Fiscal Model (GIMF) and Independent Economics’ Computable General Equilibrium Model suggest a range of estimates between 1.15 and 1.75.

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Modelling results also suggest a small impact on industry composition. Reducing the cap lowers the exchange rate and terms of trade, thereby supporting output growth in export-oriented and import-competing industries, such as agriculture, mining and manufacturing. On the other hand, more domestically-focused industries, such as construction and services, grow more slowly with tighter caps. The impact is relatively small with changes in sector output levels in 2020 being less than 0.4 percentage points across the alternative caps in the central policy scenario.

Chart 3.1: GNI per person under various caps and carbon prices

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Documents

· Web viewAnother contributor is the steady increase in agriculture emissions, which is not covered by carbon pricing. Growth in domestic emissions is projected to average 0.4 per